If you’re intrigued by investing in startups and you’ve determined you have the risk tolerance for this type of investment, then you’re ready to look at the difference between early and late stage investment opportunities to see what’s right for your investment portfolio. While the names easily define the stages chronologically, let’s take a closer look at some of the characteristics of these broad stages and what that means for investors.
Startups go through a growth period from ideation and early development to the relatively more stable late stage where they typically have demonstrated viability, have a well-known product, and likely have reached a point of positive cash flow. While each stage has generally descriptive characteristics, every startup follows a unique path that may not perfectly align with a standard explanation of the stage.
Additionally, the growth or funding stage that a startup is in does not necessarily reflect its age. Not only is the age and growth correlation specific to the company, but, in general, the “normal” can change over time. For example, according to Pitchbook’s Q4 2019 Venture Monitor report, the median age of companies receiving angel and seed funding was 2.9 years in 2019, compared to 1.5 years in 2012, showing that the typical age of a seed stage startup is older than it used to be.
Before a startup even reaches its early stage, it goes through the seed stage. Startups seeking out seed stage financing are typically in the beginning of their company’s lifecycle. These companies have usually just developed a minimum viable product and are seeking capital to further iterate and test their product, build out their team, and formalize customer acquisition strategy and channels. These startups may also be in beta testing to acquire further data on their go-to-market strategy.
Investments in the seed stage can vary, but they are usually in the form of a convertible note. Over the past decade, more companies have begun raising larger and larger seed rounds. As reported in PitchBook’s Q4 2019 Venture Monitor, 2019 saw more than $42 billion invested across more than 3,600 deals, bringing it close to 2018’s record highs for U.S. early stage venture capital investment.
While seed stage companies are focused on product development, early stage companies have usually released a product, are finessing their market strategy, and are further developing marketing and sales channels. They are also usually generating some revenue at this point but are likely not yet profitable.
As they target breakeven or positive cash flow, early stage companies are typically pursuing investment capital to advance their customer acquisition and business development. Investments within this stage are typically preferred equity, usually in the form of Series A or Series B rounds. In 2019, the median age of startups raising early stage rounds was 3.5 years (PitchBook, Q4 2019 Venture Monitor).
Late stage startups have already developed their core product offering and focused their target market, and they have typically demonstrated some level of viability. These late stage companies often have a well-known product and strong market presence, and they may be reaching into tangential products or markets or even acquiring other startups to join their suite of products or services. Late stage startups are generally bringing in revenue and may be profitable or are approaching profitability. Late-stage investments are typically Series C, D, or later-lettered rounds. Companies raising at this stage may be using proceeds to cash out earlier-stage investors before positioning for an acquisition or initial public offering (IPO).
Startups raising a pre-seed, seed, or Series A round are likely bringing in their first outside capital. Early investors take a considerable risk as these companies and their products (or services) are unproven and most likely not yet profitable. Additionally, these early investors likely have to hold their investment for a lengthy period of time, and, as with any type of angel investing, they risk losing their entire investment. For those that do reach an IPO or acquisition to exit, the median age of a startup at its IPO for 2001–2019 was 10 years old, according to the Initial Public Offerings: Updated Statistics report by Jay R. Ritter.
The potential reward for those who invest early with a startup that eventually reaches a liquidity event is that investors may have the possibility of a healthy return on investment, as well as the satisfaction of having been part of funding “the next big thing.” Investors at these early stages typically include accelerators, seed stage venture capitalists (VCs), and angel investors who may provide unique insights to help their startups gain traction. Sometimes these early stage VCs have industries they specialize in, or a Y Combinator might provide a mentorship network.
While the investment risk is still high in all startups, late stage opportunities may seem to have a clearer path to an IPO, acquisition, or other exit. Later stage investors typically might include growth stage venture capital funds, hedge funds looking to invest before IPO, and large investment managers like Fidelity. Although no startup is guaranteed to reach an exit, investors in a late stage company are typically seeking liquidity as the startup positions itself for its next move. Investors at this point typically have different skill sets that could potentially help the company mature and prepare for an IPO.
However, many factors can affect exit timing, including unprecedented events such as the COVID-19 pandemic; according to PitchBook’s Q2 2020 Venture Monitor, the number of exits occurring in 2020 is on track to be the lowest since 2011. For late stage companies that are trending toward delaying going public, investors and employees may turn to the secondary market for more immediate liquidity.
Risk and Reward
Due to these differences in development and potential profitability, investing in early versus late stage startups holds different implications regarding risk, potential reward, length of time holding that investment, and more. Before investing you should do due diligence on the investment opportunity and make sure that you can afford to hold the investment for a long time or lose your entire investment should the startup fail.
While the risk is high, the potential for a return on investment as well as the excitement of investing in potentially up-and-coming companies is often what draws in investors for these types of investments. Do you want to invest in startups? Head over to the MicroVentures platform and check out the early and late stage opportunities that are currently live.
The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.